Interest rates between expectations and reality – II

Dahlia El-Hawary, Tuesday 3 Dec 2019

In the second of two articles, Dahlia El-Hawary follows up on the expected impacts of the Central Bank of Egypt’s new monetary policy stance on growth

Central Bank of Egypt

What are some of the pre-conditions or pre-requisites for ensuring the success of the ongoing monetary policy easing, undertaken through a series of interest-rate cuts, in stimulating growth, creating more jobs, reducing poverty and ultimately improving the Egyptian people’s social and economic welfare?

As noted in a first article in Al-Ahram Weekly, the classic view stipulates that lower interest rates will result in higher investment. This is because they lead to lower lending rates, hence lower borrowing costs, and encourage more private borrowing. This should ultimately lead to higher investment, more output, more jobs created, and ultimately higher growth rates.

It is also to be noted that among the beneficial effects are the direct impacts of reducing budgetary pressures through lower interest payments and less debt-servicing payments, while the indirect effects include diverting liquid funds away from bank deposits into investment in the real economy.

A few questions may come to mind, such as which sectors could be more appealing to attract savings channeled away from bank deposits as a result of lower interest rates? And has the incentive framework, on the regulatory and financial levels, been prepared to re-direct those savings into more productive uses in terms of investment? “More productive” means here not only a higher contribution to GDP and employment, but also the sustainability of these investments. This is an issue that has become of the utmost relevance when assessing the soundness as well as the returns of economic choices.   

But the conventional view does not take into account the possibility of what was referred to by the economist Rudiger Dornbusch in the early 1990s as the “waiting option”. In a set of articles published in the 1990s on reform programmes undertaken in the 1970s and 1980s, some developing economies with the assistance of international organisations like the World Bank and the International Monetary Fund, Dornbusch discussed some of the most important issues pertaining to the transition from economic reform to growth and specifically from stabilisation to growth.

Stabilisation refers to the adoption of sound fiscal, monetary and exchange-rate policies that aim at achieving macroeconomic stability and ensuring a non-inflationary environment that sends the right market signals to economic agents, hence enabling them to make the correct choices.

According to Dornbusch, the automatic relationship between growth and reform is not guaranteed. This could be partly because the private sector may deliberately choose to adopt a “wait and see” position by not undertaking major investments, due to their irreversible nature, until most uncertainties are resolved, he said. It could also be due to credibility considerations associated with doubts about the seriousness of the reforms.

While the credibility of the reforms is not in question in the Egyptian context, as the government is strongly committed to maintaining its reform momentum, uncertainties about the legal and regulatory frameworks may still be.

It is true that the government has undertaken a battery of regulatory reforms, including, but not limited to, the issuance of the new investment law, the new industrial licensing law, and the new income tax law, as well as amendments to the companies law, all of which aim at establishing a better investment climate for existing and potential entrepreneurs.

Yet, the private sector may need further reassurance from the state that it will be able to compete on an equal footing, especially given that the state has recently been operating in different sectors, including real estate.

Over the past few decades, the real-estate sector has undoubtedly become the most appealing investment choice for many Egyptians, and it has recently become even more so as a result of the soft payment facilities offered by real-estate developers over a relatively lengthy period reaching eight years and longer.

This is in addition to the high returns many people have earned from their bank deposits after the Egyptian pound’s devaluation in November 2016, an era that is now coming to an end given the Central Bank of Egypt’s (CBE) new monetary policy stance. High deposit rates have enabled many people to finance their purchases of real estate over the past few years.

One should note, however, that the Egyptian preference for real estate is not new and that many people have always been inclined to undertake this kind of investment for various reasons. These include the almost-guaranteed appreciation of the value of their assets over the years, which has made them a worthwhile investment even for the most non-savvy individual. But more importantly, it could be the case that the absence of well-developed plausible alternative investment options has attracted savers to such a relatively easy, or, let’s say, less risky type of investment rather than venture into industrial or agricultural businesses, for example.

Both the real estate and the construction sectors have been notably expanding over the past few years and are estimated to contribute more than 15 per cent of GDP and to grow at an average annual rate of over 11 per cent between 2019 and 2023. Such expansion has been strongly supported by the National Strategic Plan for Urban Development, whereby the government has embarked on mega-infrastructure and construction projects by developing new cities across the country, including the New Administrative Capital and New Alamein city.

Yet, the question remains of whether the real-estate sector has been attracting scarce financial and non-financial resources away from other sectors, those with more sustainable contributions to GDP, investment, employment, exports and growth, for example?

It is true that the construction sector has long been considered one of the main growth engines of the Egyptian economy. In fact, construction along with the manufacturing, petroleum production, and wholesale and trade sectors are estimated to represent over 65 per cent of the growth achieved in the 2018-2019 fiscal year. Yet, the sustainability of investment returns in the construction sector may be an issue when prioritising among alternative public investment options given the limited resources available.

An issue of concern could be that a sub-optimal allocation of scarce resources may slow down the shift to a higher growth path, even though this is a very-much needed move to generate more employment opportunities and reduce poverty. 

Having said that, however, one would hope that the beneficial effects associated with the establishment of the new cities and the development of the new infrastructure projects would support Egypt’s prospective economic growth take-off reaching seven per cent and higher. Indeed, in line with UN Sustainable Development Goal 11, the development of the new cities should improve people’s lives and enhance resource efficiency as well as productivity gains. Similarly, international organisations such as the World Bank have noted that poor infrastructure may constitute a bottleneck and could be a brake on achieving higher growth.

It is true that the Egyptian economy has shown clear signs of recovery over the past few years, with the growth rate reaching an average of about five per cent, the fiscal deficit placed on a downward trend, the inflation rate reduced to a single digit, and the exchange rate unified while the black market has been eliminated. Yet, the transition from stabilisation to a higher growth path may prove to be more challenging, as achieving, and, more importantly maintaining it, could be a non-automatic result of the stabilisation efforts.

Bold and consistent reforms on the structural-adjustment front are very much needed to address long-entrenched structural weaknesses in the financial, goods and labour markets in Egypt. Indeed, the imbalances have proven to be more pronounced, and they may inhibit the realisation of the beneficial effects of lower interest rates on the real economy, hence reducing the effectiveness of the CBE’s new monetary policy.

Moreover, a great deal of policy coordination is needed among the various sectors of the economy, both financial and real, to ensure the economy’s readiness to take off, and not to miss a real opportunity to move to a higher more sustainable growth path while ensuring that growth benefits will reach the most vulnerable groups in the society.

*The writer is a former advisor at the Ministry of Investment.

*A version of this article appears in print in the 5 December, 2019 edition of Al-Ahram Weekly.


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